Chapter 7 Notes

7
Global Markets in
Action
CHAPTER
Learning Objectives
 Explain how markets work with
international trade
 Identify the gains from international trade
and its winners and losers
 Explain the effects of international trade
barriers
 Explain and evaluate arguments used to
justify restricting international trade
How Global Markets Work
Because we trade with people in other
countries, the goods and services that we
can buy and consume are not limited by
what we can produce.
Imports are the goods and services that
we buy from people in other countries.
Exports are the goods and services we
sell to people in other countries.
How Global Markets Work
International Trade Today
Global trade today is enormous.
In 2011, global exports and imports were $22
trillion, which is one third of the value of global
production.
In 2011, total U.S exports were $2.1 trillion, which
is about 14 percent of the value of U.S.
production.
In 2011, total U.S. imports were $2.7 trillion,
which is about 18 percent of the value of total U.S.
expenditure.
Services were about 33 percent of total U.S.
exports and about 20 percent of total U.S.
imports.
How Global Markets Work
What Drives International Trade?
The fundamental force that generates
trade between nations is comparative
advantage.
The basis for comparative advantage is
divergent opportunity costs between
countries.
National comparative advantage is the
ability of a nation to perform an activity or
produce a good or service at a lower
opportunity cost than any other nation.
How Global Markets Work
The opportunity cost of producing a T-shirt is
lower in China than in the United States, so China
has a comparative advantage in producing T-shirts.
The opportunity cost of producing an airplane is
lower in the United States than in China, so the
United States has a comparative advantage in
producing airplanes.
Both countries can reap gains from trade by
specializing in the production of the good in which
they have a comparative advantage and then
trading.
Both countries are better off.
How Global Markets Work
Why the United States
Imports T-Shirts
Figure 7.1(a) shows U.S.
demand and U.S. supply
with no international trade.
The price of a T-shirt is
$8.
U.S. firms produce
40 million T-shirts a year
and U.S. consumers buy
40 million T-shirts a year.
How Global Markets Work
Figure 7.1(b) shows the
market in the United
States with international
trade.
World demand and world
supply of T-shirts
determine the world price
of a T-shirt at $5.
The world price is less
than $8, so the rest of the
world has a comparative
advantage in producing
T-shirts.
How Global Markets Work
With international trade,
the price of a T-shirt in the
United States falls to $5.
At $5 a T-shirt, U.S.
garment makers cut
production to
20 million T-shirts a year.
At $5 a T-shirt, U.S.
consumers buy 60 million
T-shirts a year.
The United States imports
40 million T-shirts a year.
How Global Markets Work
Why the United States Exports Airplanes
Figure 7.2(a) shows U.S.
demand and U.S. supply
with no international
trade.
The price of an airplane is
$100 million.
Boeing produces 400
airplanes a year and U.S.
airlines buy 400 a year.
How Global Markets Work
Figure 7.2(b) shows the
market in the United States
with international trade.
World demand and world
supply of airplanes
determine the world price of
an airplane at $150 million.
The world price exceeds
$100 million, so the United
States has a comparative
advantage in producing
airplanes.
How Global Markets Work
With international trade,
the price of an airplane in
the United States rises to
$150 million.
At $150 million, U.S.
airlines buy 200 jets a year.
At $150 million, Boeing
produces 700 airplanes a
year.
The United States exports
500 airplanes a year.
Winners, Losers, and the Net Gain from Trade
International trade lowers the price of an
imported good and raises the price of an
exported good.
Buyers of imported goods benefit from lower
prices and sellers of exported goods benefit
from higher prices.
But some people complain about
international competition: not everyone gains.
Who wins and who loses from free
international trade?
Winners, Losers, and the Net Gain from Trade
Gains and Losses from
Imports
Figure 7.3(a) shows the
market in the United
States with no international
trade.
Total surplus from T-shirts
is the sum of the consumer
surplus and the producer
surplus.
Winners, Losers, and the Net Gain from Trade
Figure 7.3(b) shows the
market in the United
States with international
trade.
The world price is $5 a
T-shirt.
Consumer surplus
expands from area A to
the area A + B + D.
Producer surplus
shrinks to the area C.
Winners, Losers, and the Net Gain from Trade
The area B is transferred
from producers to
consumers.
Area D is an increase in
total surplus.
Area D is the net gain
from imports.
Winners, Losers, and the Net Gain from Trade
Gains and Losses from
Exports
Figure 7.4(a) shows the
market in the United States
with no international trade.
Total surplus from
airplanes is the sum of the
consumer surplus and the
producer surplus.
Winners, Losers, and the Net Gain from Trade
Figure 7.4(b) shows the
market in the United
States with international
trade.
The world price of an
airplane is $150 million.
Consumer surplus
shrinks to the area A.
Producer surplus
expands to the area C + B
+ D.
Winners, Losers, and the Net Gain from Trade
The area B is
transferred from
consumers to producers.
Area D is an increase
in total surplus.
Area D is the net gain
from exports.
International Trade Restrictions
Governments restrict international trade
to protect domestic producers from
competition.
Governments use four sets of tools:




Tariffs
Import quotas
Other import barriers
Export subsidies
International Trade Restrictions
Import Tariffs
A tariff is a tax on a good that is imposed by
the importing country when an imported
good crosses its international boundary.
For example, the government of India
imposes a 100 percent tariff on wine
imported from the United States.
So when an Indian wine merchant imports a
$10 bottle of California wine, the merchant
pays the Indian government $10 import duty.
International Trade Restrictions
Import Tariffs
 The Effects of a Tariff
With free international trade, the world price
of a T-shirt is $5 and the United States imports
40 million T-shirts a year.
Imagine that the United States imposes a
tariff of $2 on each T-shirt imported.
The price of a T-shirt in the United States
rises by $2.
Figure 7.5 shows the effect of the tariff on the
market for T-shirts in the United States.
International Trade Restrictions
Import Tariffs
Figure 7.5(a) shows the
market before the
government imposes the
tariff.
The world price of a
T-shirt is $5.
With free international
trade, the United States
imports 40 million T-shirts
a year.
International Trade Restrictions
Import Tariffs
Figure 7.5(b) shows the
effect of a tariff on imports.
The tariff of $2 raises the
price in the United States
to $7.
U.S. imports decrease to
10 million a year.
U.S. government collects
the tariff revenue of $20
million a year.
International Trade Restrictions
Import Tariffs
Winners, Losers, and Social Loss from a
Tariff
When the U.S. government imposes a
tariff on imported
T-shirts:




U.S. consumers of T-shirts lose.
U.S. producers of T-shirts gain.
U.S. consumers lose more than U.S. producers gain.
Society loses: A deadweight loss arises.
International Trade Restrictions
Import Tariffs
U.S. Consumers of T-Shirts Lose
U.S. buyers of T-shirts now pay a higher price (the world price
plus the tariff), so they buy fewer T-shirts.
The combination of the higher price and the smaller quantity
bought makes U.S. consumers worse off.
So U.S. consumers lose from the tariff.
International Trade Restrictions
Import Tariffs
U.S. Producers of T-Shirts Gain
U.S. garment makers can now sell T-shirts for a higher price
(the world price plus the tariff), so they produce more T-shirts.
The combination of the higher price and the larger quantity
produced increases the profit of domestic producers
So U.S. producers gain from the tariff.
International Trade Restrictions
Import Tariffs
U.S. Consumers Lose More than U.S.
Producers Gain: Society Loses
Consumers lose more from the tariff than domestic producers
of the imported good gain because
1. Consumers pay a higher price to domestic producers
2. Consumers buy a smaller quantity of the good
3. Consumers pay the tariff revenue collected by the
government
International Trade Restrictions
Import Tariffs
The tariff revenue is a loss to consumers but not a social loss
because the government can use the revenue to buy public
services that people value.
The social loss arises because:
1. Some of the higher price paid to domestic producers pays the
higher cost of production.
The increased domestic production could have been obtained
at lower cost as an import.
2. The decreased quantity is bought at a higher price.
International Trade Restrictions
Import Tariffs
U.S. Consumers of T-Shirts Lose
U.S. buyers of T-shirts now pay a higher price (the world price
plus the tariff), so they buy fewer T-shirts.
The combination of a higher price and a smaller quantity
bought decreases consumer surplus.
The loss of consumer surplus is the loss to U.S. consumers
from the tariff.
International Trade Restrictions
Import Tariffs
U.S. Producers of T-Shirts Gain
U.S. garment makers can now sell T-shirts for a higher price
(the world price plus the tariff), so they produce more T-shirts.
But the marginal cost of producing a T-shirt is less than the
higher price, so the producer surplus increases.
The increased producer surplus is the gain to U.S. garment
makers from the tariff.
International Trade Restrictions
Import Tariffs
U.S. Consumers Lose More than U.S.
Producers Gain
Consumer surplus decreases and producer surplus increases.
Which changes by more?
Figure 7.6 illustrates the change in total surplus.
International Trade Restrictions
Import Tariffs
Figure 7.6(a) shows the total
surplus with free international
trade.
 The world price of a T-shirt
is $5.
 Imports are 40 million
T-shirts a year.
 Consumer surplus is the
area of the green triangle.
 Producer surplus is the area
of the blue triangle.
International Trade Restrictions
Import Tariffs
 The gains from trade is the
area of the dark green
triangle.
 Total surplus is the sum of
the green and blue areas.
International Trade Restrictions
Import Tariffs
Figure 7.6(b) shows the
winners and losers from a
tariff.
The $2 tariff is added to the
world price, which increases
the price in the United States
to $7 a T-shirt.
The quantity of T-shirts
produced in the United States
increases and the quantity
bought in the United States
decreases.
International Trade Restrictions
Import Tariffs
Consumer surplus shrinks
to the green area.
Producer surplus expands
to the blue area.
Area B is a transfer from
consumer surplus to producer
surplus.
Imports decrease.
Tariff revenue equals area D:
Imports of T-shirts multiplied
by $2.
International Trade Restrictions
Import Tariffs
Society Loses: A Deadweight Loss Arises
Some of the loss of consumer surplus is transferred to
producers and some is transferred to the government as tariff
revenue.
But the increase in production costs and the loss from
decreased imports is a social loss.
International Trade Restrictions
Import Tariffs
The cost of producing a
T-shirt in the United States
increases and creates a
social loss shown by area C.
The decrease in the quantity
of imported T-shirts creates a
social loss shown by area E.
The tariff creates a social loss
(deadweight loss) equal to
area C + E.
Comparing Free Trade With An
Import Tariff
International Trade Restrictions
Import Quotas
An import quota is a restriction that
limits the maximum quantity of a
good that may be imported in a given
period.
For example, the United States
imposes import quotas on food
products such as sugar and bananas
and manufactured goods such as
textiles and paper.
International Trade Restrictions
Import Quotas
The Effects of an Import
Quota
Figure 7.7(a) shows the
market before the
government imposes an
import quota on T-shirts.
The world price is $5.
The United States imports
40 million T-shirts a year.
International Trade Restrictions
Import Quotas
Figure 7.7(b) shows the
market with an import quota
of 10 million T-shirts.
With the quota, the supply
of T-shirts in the United
States becomes S + quota.
The price rises to $7.
The quantity produced in
the United States increases
and the quantity bought
decreases.
Imports decrease.
International Trade Restrictions
Import Quotas
Winners, Losers, and Social Loss from an
Import Quota
When the U.S. government imposes an
import quota on imported T-shirts:
 U.S. consumers of T-shirts lose (price is higher).
 U.S. producers of T-shirts gain.
 Importers of T-shirts gain.
 Society loses: A deadweight loss arises.
Figure 7.8 illustrates the winners and losers with an import
quota.
International Trade Restrictions
Import Quotas
Figure 7.8(a) shows the
total surplus with free
international trade.
Total surplus is maximized.
International Trade Restrictions
Import Quotas
The import quota raises the price of a
T-shirt to $7 and decreases imports.
Area B is transferred from consumer
surplus to producer surplus.
Importers’ profit is the sum of the two
areas D (they buy for $5 and sell for
$7).
The area C + E is the loss of total
surplus—a deadweight loss created
by the quota.
The difference between a quota and a
tariff is that a tariff brings in revenue
for the government while a quota
brings in additional profits for the
importer (areas D).
Comparing Free Trade With the
Effects of an Import Quota
International Trade
Restrictions
Other Import Barriers
Thousands of detailed health, safety, and
other regulations restrict international trade.
Export Subsidies
•An export subsidy is a payment made by the
government to a domestic producer of an exported
good.
•Export subsidies bring gains to domestic producers,
but they result in overproduction in the domestic
economy and underproduction in the rest of the
world and so create a deadweight loss.
The Case Against Protection
Despite the fact that free trade promotes
prosperity for all countries, trade is restricted.
Seven arguments for restricting international
trade are that protecting domestic industries
from foreign competition







Helps an infant industry grow
Counteracts dumping
Saves domestic jobs
Allows us to compete with cheap foreign labor
Penalizes lax environmental standards
Prevents rich countries from exploiting developing countries
Reduces offshore outsourcing that sends U.S. jobs abroad
The Case Against Protection
Helps an Infant Industry to Grow
Comparative advantages change with on-the-job
experience called learning-by-doing.
When a new industry or a new product is born—
an infant industry—it is not as productive as it will
become with experience.
It is argued that such an industry should be
protected from international competition until it
can stand alone and compete.
 Learning-by-doing is a powerful engine of
productivity growth, but this fact does not justify
protection.
The Case Against Protection
Counteracts Dumping
Dumping occurs when a foreign firm sells its
exports at a lower price than its cost of
production.
This argument does not justify protection
because
1. It is virtually impossible to determine a firm’s costs.
2. It is hard to think of a global monopoly, so even if all
domestic firms are driven out, alternatives would still exist.
3. If the market is truly a global monopoly, it is better to
regulate the monopoly rather than restrict trade.
The Case Against Protection
Saves Domestic Jobs
The idea that buying foreign goods costs
domestic jobs is wrong.
Imports destroy some jobs but create jobs for
retailers that sell the imported goods and for firms
that service these goods.
Free trade also increases foreign incomes and
enables foreigners to buy more domestic
production.
Protection to save particular jobs is very costly.
The Case Against Protection
Allows Us to Compete with Cheap
Foreign Labor
The idea that a high-wage country cannot
compete with a low-wage country is
wrong.
Low-wage labor is less productive than
high-wage labor.
And wages and productivity tell us
nothing about the source of gains from
trade, which is comparative advantage.
The Case Against Protection
Penalizes Lax Environmental Standards
The idea that protection is good for the
environment is wrong.
Free trade increases incomes and poor countries
have lower environmental standards than rich
countries.
These countries cannot afford to spend as much
on the environment as a rich country can and
sometimes they have a comparative advantage at
doing “dirty” work, which helps the global
environment achieve higher environmental
standards.
The Case Against Protection
Prevents Rich Countries from
Exploiting Developing Countries
By trading with people in poor
countries, we increase the demand for
the goods that these countries produce
and increase the demand for their labor.
The increase in the demand for their
labor raises their wage rate.
Trade can expand the opportunities
and increase the incomes of people in
poor countries.
The Case Against Protection
Reduces Offshore Outsourcing that Sends
U.S. Jobs Abroad
Offshore outsourcing occurs when a firm in the
United States buys finished goods, components,
or services from firms in other countries.
Despite the gain from specialization and trade
that offshore outsourcing brings, many people
believe that it also brings costs that eat up the
gains. Why?
Americans, on average, gain from offshore
outsourcing, but some people lose.
The losers are those who have invested in the
human capital to do a specific job that has now
gone offshore.
The Case Against Protection
Why Is International Trade Restricted?
The key reason why international trade restrictions
are popular in the United States and most other
developed countries is an activity called rent seeking.
Rent seeking is lobbying and other political activity
that seeks to capture the gains from trade.
You’ve seen that free trade benefits consumers but
shrinks the producer surplus of firms that compete in
markets with imports.
The Case Against Protection
Those who gain from free trade are the millions
of consumers of low-cost imports.
But the benefit per individual consumer is small.
Those who lose are the producers of importcompeting items.
Compared to the millions of consumers, there
are only a few thousand producers.
These producers have a strong incentive to incur
the expense of lobbying for a tariff and against
free trade.
The Case Against Protection
The gain from free trade for any one
person is too small for that person to
spend much time or money on a
political organization to lobby for free
trade.
Each group weighs benefits against
costs and chooses the best action for
themselves.
But the group against free trade will
undertake more political lobbying than
will the group for free trade.